ANALYSIS

CalPERS looks for risk managers in fixed income

Introducing specialist risk management professionals within the fixed-income team is one of Wilshire Consulting’s recommendations to CalPERS following its review of the internal team, investment process and resources.Since the last review of the internal fixed-income team, CalPERS has made a number of personnel and system additions, which have raised the overall ranking as measured by Wilshire’s external manager rating system. But the consultant still believes there are a number of operational improvements that could help mitigate the potential for compliance risk.

“We found that the team manages the portfolio in an effective, risk-aware manner and has state-of-the-art systems to assist in monitoring and managing the portfolio. It could be worth exploring whether professionals dedicated solely to risk management should be introduced in the fixed-income group,” a report to the board said.

This would both increase the number of layers of review for the portfolio, thus redistributing the workload of the senior investment officer-fixed income, and help to complement the work of the total portfolio risk management team.

There are also a couple of areas Wilshire believes could be improved as it relates to operational risk management and compliance.

While it acknowledges that since the last review reinforcing a culture of compliance and empowering employees to question portfolio data that appears abnormal has been another positive step, it says introducing more explicit delegations of authority for portfolio managers would enhance accountability and provide a framework for reviewing staff actions.

This would include improving documentation on guidelines, purposes, allowable investments, and strategic intent.

“The senior investment officer-fixed income feels an individual with a controller’s background would have the right skill set to complete the project, but the hiring of someone with those capabilities has not occurred although it is being pursued. These delegations of authority would of course need to be balanced with providing an appropriate level of flexibility to make timely investment decisions across the internal fixed-income portfolio.”

Wilshire believes having compliance personnel within the investment division reporting to the CIO is not best-practice, and ensuring the compliance remains independent from investments is of paramount importance.

In addition Wilshire is proposing that to improve the efficiency of the fixed-income group, centralising the trading function would be beneficial.

“This would ensure trading would become an integral part of the portfolio management process. Secondarily, this would mitigate some operational risks as trading and portfolio management would be separate functions, providing checks and balances for each function.”

According to Wilshire there are two risks in the fixed-income team that are CalPERS’ specific: maintaining and upgrading systems and technology so the team does not face disadvantage versus other investors; and CalPERS cannot match the retention incentive of non-government organisations, and is more at risk of losing intellectual capital than a for-profit enterprise.

At a portfolio level, the duration of the portfolio is kept very close to the duration of the index, ameliorating much of the interest rate risk relative to the index. And the senior investment officer-fixed income has decided to rein in the risk across the portfolio to more closely align the performance of the fixed-income portfolio with the goals and objectives of the system as a whole.

Discussions are currently underway to explore breaking out a separate allocation to US Treasuries and TIPS to provide a ready source of liquidity and insurance against the next credit crisis, and this discussion is part of the asset allocation process.

CalPERS’ staff has sector specialists who focus on credit and structured products and who are highly knowledgeable and manage respective sectors of the portfolio against appropriate benchmarks. A new senior portfolio manager is now overseeing global government securities, and an experienced portfolio manager is likely to join the team in the near future to manage the sovereign portfolio.

In addition, two new research professionals were hired this year. While this is clearly a step in the right direction, Wilshire believes that additional depth in the credit team should be a long-term goal for the system.

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